GIL: Not Looking Good

Keith shorted GIL in the Hedgeye portfolio today. “GIL, shorting - Looking for names that are up that our analysts don't like from an intermediate term TREND perspective. Brian McGough is bearish on Gildan's prospective margin outlook.”

Here’s some added color on our fundamental view by duration.

Long-term

GIL is the kind of name where most people don’t ‘kinda like it’ or ‘kinda dislike it’. This name is either pure love or hatred. I’m more of the latter’s camp. I absolutely buy into several parts of Gildan’s model. They are, without a doubt, the low-cost provider of socks, underwear, and Ts – the staples of most wardrobes. They were the first company to successfully migrate production overseas while maintaining a vertical (as opposed to outsourced) production model.

What did they do with all those cost saves? On one hand, they more than doubled market share in the blank T business to somewhere between 60-70% of the market, and they also took share in Fleece to near 50%. Those are simply astounding numbers, and should be commended by even the most crotchety of bears. But while gaining share, that ALSO doubled EBIT margins to 16%. They had a big slice of cake and ate it too.

But then they got to a point where they had to look elsewhere for growth. First it was in mass channels (especially Wal*Mart). Then when that turned out to be a weaker return business than they planned, International growth seemed like a good idea to them (make product in Honduras, and ship to China to compete with local factories than can make it cheaper???). Now they’re back to mass channels in working with companies like Iconix to grow both brands.

Could that work? Maybe. But the crux of our case is that these are ALL margin and ROIC-dilutive businesses. GIL’s SG&A ratio is simply too low. It never had to focus on marketing. Now it does. A 10% SG&A ratio is already heading up to 11.5% next year. That comes right out of margin.

The tax rate is sitting at about zero. There’s the American/Honduran/Canadian-domiciled system hard at work. Will it stay low forever. Not sure. But it’s sure as heck not going down.

The offshoring + tax rate + weak competition made the last decade sweet for GIL. But that’s done. Now they can, and will grow units at the rate of new capacity growth (which they need to fund). There’s negative pricing power beyond GIL’s core Blanks business. And we can’t underestimate the impact of Hanesbrands, which sits today where GIL was 8 years ago in its restructuring. That’s not to be ignored given that HBI is 3.5x the size of GIL and they compete on the fringes more and more each day.

The long-term punchline is that current margins of 16% are a new peak, and there are headwinds coming.

Intermediate-Term

Sometimes lousy long-term stories make great stocks – over shorter durations. Unfortunately for GIL, this is one of those times where a lousy company should = a lousy stock. The model tells it all…

a) This year (which just ended), GIL will put up about 25% top line growth and about 100% EBIT growth. Starting 1 quarter out, GIL needs to go up against yy revenue comparisons of +20%, then +33%... It’s not pretty, and new capacity is unlikely to support the 20% growth that the consensus thinks will happen AGAIN next year.

b) $1.28 in cotton. Also not great that GIL has been trying (unsuccessfully) to hire HBI’s head of raw materials sourcing. Lastly, SG&A is headed up by about 150bps next year.

c) Capex seems fairly controlled, but the $130mm in capex they’re likely to report excludes the $25mm that they bumped into next year 2 quarters ago.

d) Check out GIL’s SIGMA chart below. Headed in the wrong direction.

Short-Term:

a) EPS report on December 2. We’re at $0.44 vs. the Street at $0.46.

b) We wouldn’t fall out of our chairs if they do a few pennies higher. That’s driven by 2 factors…

Print a great quarter, make the year, get everyone paid. Then worry about 2011.

On the top line, GIL can pretty print whatever it wants. Instead of pushing revenue through its own pipe, it can outsource last minute. But then that margin goes to the customer and consumer, not to GIL. But if they push the capacity lever hard enough this could still help the quarter.

Lastly, 2001 guidance will not be pretty. We could literally see margins down 300bps – not the paltry 20bps currently in the Street’s numbers. If there is not a guide down, this name will have a whole lot of hope built into it. With the most favorable sell-side sentiment this name has had in over 2 years -- they need all the hope they can get. Fortunately for us, and hopefully for you, we realize that hope is not an investment process.

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